Are you investing in Tax Free Bonds? With Tax Free Bonds, the taxpayer can get many benefits. Read the complete article to know the benefits, how to apply for Tax Free Government Bonds, Comparision between normal and tax free bonds, etc.

Bonds and Types of Bonds in India

Bonds are a type of debt instrument. By investing in this type of asset (Bonds), the investor gives a loan to the issuing entity. The investors will be repaid at the end of the tenure. There are several types of bonds. Two types of bonds through which the tax charged to a person can be reduced in India are Tax Free Bonds and Capital Gain Bonds.

Tax Free Bonds

Under Section 10 of Income Tax Act, 1961, the bonds on which the interest received is exempted from tax or the bonds that are exempted from tax on the interest income are called Tax Free Bonds. But, for the income tax payment you cannot claim for the deduction of the principle amount invested in these bonds from the total income.

Capital Gain Bonds

Under Income Tax Act, 1961, the bonds on which the interest received is not exempted are called as Capital Gain Bonds. But, under Section 54EC, the principle amount invested in these capital gain bonds can be claimed as an exemption from the Capital Gains.

Tax Free Bonds

Central Government has to approve the Tax Free Bonds before issuance. Under Section 10 (15)(iv)(h) of the Income Tax Act, the interest received on these bonds is fully exempted from the levy of the income tax. However, you need to include that in the Income Tax return as an exempted income. Many people don’t include such interests knowingly or unknowingly. If you have not declared the exempted interest income in the return then it may result in an Income Tax Notice.

Comparision between Normal Bonds & Tax Free Bonds

Compared to the normal bonds the interest received on these Tax Free Bonds is slightly low. But after-tax returns are higher for the tax free bond i.e., tax free bonds are better than normal bonds as the interest earned from these tax-free bonds are exempted from tax. They also have a lower risk of default. These bonds are best for taxpayers who fall in the high slab categories of 20% and 30% as the interest received from these Tax Exempt Bonds is tax-free.

Assume the Interest rate = 10%. Here the 10% interest rate is assumed one but in practise the interest received on the Tax Free Bonds is slightly lower than Normal Bonds.

Then, the interest earned = Rs. 100

Tax on interest earned for Normal Bonds

Rs. 20 for taxpayers who fall in the high slab categories of 20%.

Rs. 30 for taxpayers who fall in the high slab categories of 30%.

Tax on interest earned for Tax-free Bonds

Nil for taxpayers who fall in the high slab categories of 20%.

Nil for taxpayers who fall in the high slab categories of 30%.

After tax returns for Normal Bonds

Rs. 80 for taxpayers who fall in the high slab categories of 20%.

Rs. 70 for taxpayers who fall in the high slab categories of 30%.

After tax returns for Tax Free Bonds

Rs. 100 for taxpayers who fall in the high slab categories of 20%.

Rs. 100 for taxpayers who fall in the high slab categories of 30%.

Saving (Redemption) of Tax Free Bonds

The tax free bonds come with a lock-in period of 10-20 years. Before the end of this lock-in period, you will not be paid with the principle amount invested in these government bonds. But, these tax exempt bonds are free traded on the stock exchanges. You (bond holder) can sell these bonds to some other person except to the authority who issued these bonds. In such case, the buyer would earn interest reduced by 0.25% to 0.50%. On sale of these bonds, if there is any gain, that would be liable to tax as Capital Gains.

On sale of tax free bonds before 1 year, the gains if any, would be taxed as per the slab rates of Income Tax.

On sale of these bonds after 1 year, the gains if any, would be taxed at the rate of 20% (if indexation is done) and 10% of profit (if indexation is not done).

Instructions regarding Tax Free Bonds

The general instructions regarding Tax Free Bonds are as follows. Know how to apply for Tax Free Government Bonds.

If the allotment of the bonds is in dematerialsed form, make sure that the details about beneficiary account and depository participant are correct and the beneficiary account is active. If the application form is submitted in joint names, make sure that the beneficiary account is also held in same joint names and such names are in the same sequence in which they appear in the application form.

You need to disclose the PAN Number in the application form. The application form without the PAN number is liable to be rejected.

Applicants are required to write their application number and names on the backside of the cheque by which the payments are made.

You should not pay the application amount by money order or in cash.

You should not send the application forms by post. You have to submit the application forms to the members of the SCSBs, syndicate, and trading members (as the case may be) only.

Documents Required to get Tax Free Bonds

Duly filled application form.

Self-attested copy of your proof of residence

Self-attested copy of the PAN card.

The documents that are considered as a proof of residence are as follows. Submit any on of the following documents as a proof of residence:

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